Martin Sandbu’s book is a robust and generally well-informed critique of the handling of the euro-area crisis. An enthusiast for the euro, he is careful not to throw the baby out with the bathwater.
Neither the euro itself nor its basic design is at the root of the euro problem in the author's view. Instead, he believes, the main problem with the management of the euro crisis is that European policymakers have unduly prioritised debt repayment over macroeconomic demand management. This message is not dramatically new, but neither is it fundamentally flawed, and the Financial Times journalist delivers it with verve through a fast-paced and opinionated account.
A word of warning, though: the approach is schematic rather than one of carefully documented historical reportage. The account of the Ireland dimension is particularly stylised and sketchy. In fact this reviewer was quite dismayed to see the way that the book’s account misinterprets his own motivations and actions.
The author is surely correct that the sudden emergence of an unsustainable Greek debt and deficit position should have triggered a more comprehensive and earlier response, instead of just a prolonged period of substituting official for private lending, as the private sector – international banks, pension funds and others – scrambled to escape. For Greece, though, the issue is not really to whom it owes the debt but its need for a realistic long-term prospect regarding the degree to which it will have to service its debt.
Sandbu has few doubts or hesitations, a characteristic that will be attractive to some readers. Excoriating Europe for not having reached the right solutions, he spends little time assessing the challenging politics of arriving at better debt-management solutions when a score of countries are involved, most of them on the creditor side of the issue.
Then again it’s not just a question of creditors versus debtors. Indeed, Sandbu shrewdly observes the role of German policymakers. Of course Germany could never be accused of advocating laxity in monetary or fiscal policy. Cavalier approaches to the accumulation of debt were, after all, the fundamental cause of the crisis. But, determined not to turn the euro area into a “transfer union” where taxpayers in frugal countries would end up paying for the profligate, German policymakers have consistently argued for bail-in of private creditors of bust banks and overly indebted sovereigns.
It is a nice paradox that, in 2010 and 2011, it was fear of the unknown on the part of other countries that led them to reject that approach in each case, fearing the consequences for the next-weakest countries, and for the system as a whole.
Depositors’ losses
Not all of the private-sector lenders to the Greek government escaped; those remaining lost about half of their investment in the restructuring of 2012. Some depositors in Cyprus also lost heavily in 2013 as European officials belatedly recognised that the risks of allocating some of the burden of bank failures to large bank creditors did not outweigh the savings to national governments.
This was a realisation that came too late to affect Irish senior bank bondholders (but which surely influenced the attitude of partner countries to the “promissory note” arrangement worked out around the liquidation of IBRC). The principle that large bank creditors should share the cost of bank failures is now embodied in European bank-resolution legislation.
Still, Sandbu’s single-minded enthusiasm for the panacea of debt restructuring looks somewhat glib. He brushes aside adverse side effects and does not discuss the central question that has exercised scholars of sovereign-debt distress for many years: how to identify when the level of debt has got to the point where sustainability is not assured; and what international governance structures could be successfully instituted to give practical effect to the ideas he is championing.
So, all in all, Sandbu is surely largely correct in his conclusion that more bail-in and more aggregate demand would have helped generate a faster recovery. But it would have been good to see him tease out the pros and cons less censoriously, to help understand why more was not done faster to ensure a sensible allocation of the losses embedded in unsustainable national or banking debts, and why countries with budgetary headroom did not do more to support demand and economic activity in Europe.
Debt burden
And what about innovative solutions to borderline cases that might help remove the fear of misbehaviour by those who have been given debt relief? Almost nothing has been achieved along the lines of direct investment of collective official euro-area capital into failing banks. (Instead the governments of Spain, Slovenia, Greece and Ireland, among others, have had to assume an additional debt burden to cover the needed sums.) And there has been no move to make financial assistance take the form of recovery-linked debt (where the borrower government need not service as much debt if its economy doesn’t recover as planned). Sandbu mentions some of this but has little to say about what might be a politically practical way of achieving an economically more efficient outcome.
Finally there is the overall question of insufficient aggregate macroeconomic demand, which has undoubtedly added to unemployment in Europe since the crisis. Most credible commentators, while bemoaning the excessive debt that has resulted from governments’ stabilising spending in 2008-9, the initial years of the downturn, believe that countercyclical fiscal expansion was terminated too soon. This applies to the US and UK as well as to the euro area, although it is generally acknowledged that the stressed countries (Ireland included) could not realistically have spent much more. Here at least ideology, culture and history may play a part. Those who most oppose a more activist countercyclical fiscal policy also tend to be attached to discipline and rule-driven behaviour. Whatever the effect on overall welfare and growth in their economies, adherence to such a culture tends to leave one in a creditor position and, as such, to begin the negotiation game with a stronger hand.
Although Europe's Orphan is well documented, and reminds us of the many twists in the euro crisis, it is hard to shake off the impression that the author has marshalled the evidence to support a rather oversimplified and overstated line of argument and interpretation.
Patrick Honohan is governor of the Central Bank of Ireland
